Sensex Can Go to 25,000 Before it Goes to 60,000. Are You Prepared?

Sep 21, 2020

Rahul Shah, Editor, Profit Hunter

Here's something interesting about the stock market in general.

The broader market is more like a satellite revolving in fixed orbits and less like a rocket that disappears in outer space.

Put differently, whenever the stock market falls from a record high, it just doesn't fall below its current highs. It also falls below the previous high before resuming its upward journey. It keeps moving between two points longer than you could have thought.

For e.g. back in the 90s, the Sensex closed above 5,000 mark for the first time in 1999.

But then came a sharp correction and by 2001, it had completely wiped out the gains of the past five years. It had fallen back to the 1996 levels. So, it moved between 3,000 and 5,000 for a good amount of time before breaking out.

The story repeated itself in 2007-08. In 2007, the Sensex scaled an all-time high level of 20,000 and by the end of the next year, Sensex was at the same level it was three years back.

It took the Sensex a total of six years to break away meaningfully from the highs it had reached in 2007.

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And then of course the most recent meltdown. Sensex closed the year 2019 with at more than 40,000 for the first time in history only to come crashing down on account of the Coronavirus pandemic.

At the bottom of the market in March this year, the Sensex had fallen back to the 2015 levels. Thus, yet another example of the Sensex moving in orbit instead of going off on a tangent on a permanent basis.

Therefore, if you are relying on this theory of the stock market, you could well argue that the stock market bottomed out in March 2020 and there won't be any meaningful correction now before the Sensex scales a new high.

Thus, the Sensex can again fall to 30k-35k levels but not before touching the 60-70k mark a year or two from now.

Well, anything is possible in the stock market.

However, I would like to believe there's a good chance the markets can correct again and quite significantly at that, before they embark on their journey of creating a new high.

There are a couple of reasons I believe so. Number one, this bear market has ended rather abruptly. We are having the worst economy in almost four decades and yet, the Sensex has recovered most of its gains in a matter of few months.

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Of course, the Sensex does bottom out much earlier than the economy. However, even by that yardstick, I believe there's one more correction left in the Sensex before it embarks on its journey of creating a new high every few years.

Number two are the valuations. Perhaps for the first time in my career, I am highly certain that forward earnings of the Sensex i.e. earnings for the fiscal FY21, will come in lower than FY20.

Which means that if the Sensex is expensive based on its historical EPS (Earnings Per Share), it is even more expensive based on FY21 EPS. This can act as another dampener for the stock prices.

Thus, if I am expecting Sensex to have one more big crack, should one get out of stocks completely and get back in when at lower levels.

Absolutely not. Even though I have high conviction that the Sensex can correct, it is just one of the possibilities out there. Another possibility is that the markets can continue to go higher or perhaps, even stay at these levels with some stocks doing well while the others not that much.

Therefore, here's my gameplan.

I will never be fully invested in the stock market or be fully out of it. I will remain at least 25% invested in the stock market or in cash at all times.

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So, say if you had moved to 75% stocks and 25% cash in March 2020 earlier this year when the stock market had crashed, you can may be go back to 50:50 allocation and take some profits off the table.

Alternatively, if you think the chance of a stock market correction is high, you can book more profits and go into cash to the tune of 75%.

Lastly, if you are the kind who prefers being aggressive and willing to ride the volatility, you can also stay 75% in stocks and only 25% in cash.

As far as I am concerned, I would prefer an allocation of around 50:50 or may be slightly higher. Please note that this is as close as one can come to a fixed formula for doing well in the stock market. If it were any simpler, everyone would have copied it and the formula would have stopped doing well just because of this reason.

Remember, your edge lies in doing things differently from the crowd. If everyone is doing it, it is no longer an edge.

By the way, here's a good tutorial on how you should go about picking stocks in the current market.

Warm regards,

Rahul Shah
Rahul Shah
Editor and Research Analyst, Profit Hunter

PS: Equitymaster's smallcap editor, Richa Agarwal has picked her top stock for 2021. Get the details of this stock here.

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